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PUBLISHED

UNITED STATES COURT OF APPEALSFOR THE FOURTH CIRCUIT

PUBLIC EMPLOYEES’ RETIREMENT

ASSOCIATION OF COLORADO; GENERIC

TRADING OF PHILADELPHIA, L.L.C.,Plaintiffs-Appellants,

No. 07-1704v.

DELOITTE & TOUCHE LLP;DELOITTE & TOUCHE ACCOUNTANTS,

Defendants-Appellees. Appeal from the United States District Court

for the District of Maryland, at Baltimore.Catherine C. Blake, District Judge.

(1:03-md-01539-CCB; 1:03-cv-01825-CCB)

Argued: October 28, 2008

Decided: January 5, 2009

Before WILKINSON and AGEE, Circuit Judges, andJohn T. COPENHAVER, JR., United States District Judge

for the Southern District of West Virginia,sitting by designation.

Affirmed by published opinion. Judge Wilkinson wrote theopinion, in which Judge Agee and Judge Copenhaver joined.

COUNSEL

ARGUED: Andrew John Entwistle, ENTWISTLE & CAP-PUCCI, L.L.P., New York, New York, for Appellants. Daniel

F. Kolb, DAVIS, POLK & WARDWELL, New York, NewYork; John T. Behrendt, GIBSON, DUNN & CRUTCHER,L.L.P., New York, New York, for Appellees. ON BRIEF:Johnston de F. Whitman, Jr., Richard W. Gonnello, Jordan A.Cortez, ENTWISTLE & CAPPUCCI, L.L.P., New York,New York; ADELBERG, RUDOW, DORF & HENDLER,L.L.C., Baltimore, Maryland, for Appellants. Marshall R.King, Lee G. Dunst, LaShann M. DeArcy, GIBSON, DUNN& CRUTCHER, L.L.P., New York, New York, Daniel F.Goldstein, BROWN, GOLDSTEIN & LEVY, L.L.P., Balti-more, Maryland, for Appellee Deloitte & Touche Accoun-tants; Sharon Katz, Jane Alexandra Small, Joshua D. Liston,DAVIS, POLK & WARDWELL, New York, New York, MaxH. Lauten, KRAMON & GRAHAM, P.A., Baltimore, Mary-land, for Appellee Deloitte & Touche LLP.

OPINION

WILKINSON, Circuit Judge:

This class action securities fraud lawsuit arises out ofimproper accounting by Royal Ahold, N.V., a Dutch corpora-tion, and U.S. Foodservice, Inc. ("USF"), a Maryland-basedAhold subsidiary. The misconduct of Ahold and USF is notdisputed in this appeal; at issue is the liability of Ahold’saccountants, Deloitte & Touche LLP ("Deloitte U.S.") andDeloitte & Touche Accountants ("Deloitte Netherlands"), fortheir alleged role in the fraud perpetrated by Ahold and USF.Under the Private Securities Litigation Reform Act("PSLRA"), Pub. L. No. 104-67, 109 Stat. 737, plaintiffs mustplead facts alleging a "strong inference" that the defendantsacted with the required scienter. As recently explained by theSupreme Court in Tellabs, Inc. v. Makor Issues & Rights,Ltd., 127 S. Ct. 2499 (2007), a strong inference "must bemore than merely plausible or reasonable — it must be cogentand at least as compelling as any opposing inference of non-

2 PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE

fraudulent intent." Id. at 2504-05. Because we find the infer-ence that the Deloitte defendants lacked the necessary scientermore compelling than any competing inference that theyknowingly or recklessly perpetrated a fraud on Ahold’s inves-tors, we affirm the district court’s judgment that plaintiffs’motion for leave to file a second proposed amended complaintwas futile.

I.

Ahold owns and operates grocery stores and food servicecompanies in the United States and other countries. DeloitteU.S. is an American accounting firm that audited Ahold’sAmerican subsidiaries and acted as a filing reviewer forAhold’s filings with the Securities and Exchange Commission("SEC"). Deloitte Netherlands is a Dutch accounting firm thatserved as Ahold’s outside auditor. Although they workclosely together, the two Deloittes are legally distinct entities.

Beginning in the 1990s, and continuing until 2003, Aholdperpetrated two frauds that led it to significantly overstate itsearnings on financial reports. First, Ahold improperly "con-solidated" the revenue from a number of joint ventures withsupermarket operators in Europe and Latin America ("the JVfraud"). That is, for accounting purposes Ahold treated thesejoint ventures as if it fully controlled them — and thus treatedall revenue from the ventures as revenue to Ahold — whenin fact Ahold did not have a controlling stake. Under Dutchand U.S. generally accepted accounting principles (GAAP),Ahold should only have consolidated the revenue proportion-ally to Ahold’s stake in the ventures.

Second, USF falsely reported its income from promotionalallowances ("the PA fraud"). Also known as vendor rebates,promotional allowances ("PAs") are payments or discountsthat manufacturers and vendors provide to retailers like USFin order to encourage the retailers to promote the manufactur-ers’ products. In order to increase its stated income, USF pre-

3PUBLIC EMPLOYEES’ RETIREMENT v. DELOITTE & TOUCHE

maturely recognized income from PAs and inflated itsreported PA income beyond amounts actually received.

On February 24, 2003, Ahold announced that its earningsfor fiscal years 2001 and 2002 had been overstated by at least$500 million as a result of the fraudulent accounting for pro-motional allowances at USF and that Ahold would be restat-ing revenues because it would cease treating the joint venturesas fully consolidated. After this announcement, Ahold com-mon stock trading on the Euronext stock exchange and AholdAmerican Depository Receipts trading on the New YorkStock Exchange lost more than 60% of their value. Subse-quent to the February 2003 announcement, Ahold made fur-ther restatements to its earnings totaling $24.8 billion inrevenues and approximately $1.1 billion in net income.

As a result of the frauds, the SEC filed civil enforcementactions against Ahold and several individual defendants. Sep-arately, twenty-one private class action securities and ERISAactions were filed against Ahold, both Deloittes, and otherdefendants. On June 18, 2003, the Judicial Panel on Multidis-trict Litigation transferred them to the U.S. District Court forthe District of Maryland. In re Royal Ahold N.V. Securities &"ERISA" Litig., 269 F. Supp. 2d 1362 (J.P.M.L. 2003). Subse-quently, several more related actions were also transferred tothe District of Maryland.

On November 4, 2003, the district court consolidated allthe actions and designated plaintiffs Public Employees’Retirement Association of Colorado and Generic Trading ofPhiladelphia, LLC as Lead Plaintiffs. In re Royal Ahold N.V.Securities and ERISA Litig., 219 F.R.D. 343 (D. Md. 2003).On February 18, 2004, the Lead Plaintiffs filed a Consoli-dated Amended Securities Class Action Complaint ("CAC")against Ahold, several Ahold subsidiaries, both Deloittes, andsome of Ahold’s underwriters, officers, and directors. TheCAC charged Ahold, its subsidiaries, the Deloittes, and theindividual defendants with violations of § 10(b) of the Securi-


ties Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5(b), as well as 10b-5(a) and (c), 17 C.F.R. § 240.10b, pro-mulgated thereunder, and also charged some defendants withother violations of the securities laws not relevant here.

Both Deloittes moved to dismiss the CAC on severalgrounds. The district court on December 21, 2004, dismissedall of the claims against both Deloitte defendants for failureto state a claim, and held that with respect to the § 10(b)claims the complaint did not plead facts alleging a stronginference of scienter as required by the PSLRA. In re RoyalAhold N.V. Securities & ERISA Litig., 351 F. Supp. 2d 334,385-96 (D. Md. 2004). The district court also dismissed somebut not all of the claims against the other defendants on vari-ous grounds.1 See id. at 411. The plaintiffs continued the liti-gation on the remaining claims and proceeded with discovery.On November 28, 2005, Ahold and the Lead Plaintiffsannounced a $1.1 billion settlement resolving the Class’sclaims against all the defendants other than Deloitte U.S. andDeloitte Netherlands.

On March 6, 2006, the Lead Plaintiffs filed a motion toamend the original complaint accompanied by a proposedSecond Consolidated Amended Securities Class Action Com-plaint ("SAC"). The SAC alleged two causes of action: oneunder Rule 10b-5(b), and one under both 10b-5(a) and (c).After briefing and oral argument, the district court denied themotion on the basis of futility, for it determined that theamended motion still did not meet the PSLRA’s requirementthat it allege a strong inference of scienter against the Deloit-tes. Plaintiffs timely appealed.

1The district court also dismissed all allegations regarding conductbefore July 30, 1999 as time-barred. In re Royal Ahold, 351 F. Supp. 2dat 364-68. Thus, the Class Period at issue in this litigation runs from July30, 1999 to February 23, 2003.


II.

This appeal turns on Ahold’s accountants’ alleged role inthe JV and PA frauds. Accordingly, we shall review thefrauds and the Deloittes’ roles in them as indicated by therecord. Although Ahold began consolidating its joint venturesin 1992, the purported class period did not begin until July 30,1999. Our discussion of events before that date serves only toprovide background for later events.

A.

With respect to the JV fraud, both Deloittes advised Aholdon the consolidation of the joint ventures. Five joint venturesare at issue in this litigation: JMR, formed in August 1992;Bompreço, formed in November 1996; DAIH, formed in Jan-uary 1998; Paiz-Ahold, formed in December 1999; and ICA,formed in February 2000. Ahold had a 49% stake in JMR anda 50% share of each of the other ventures at their respectivetimes of formation.

Prior to Ahold’s entering into the first joint venture,Deloitte Netherlands and Deloitte U.S. gave Ahold adviceabout revenue consolidation under Dutch and U.S. GAAP.For example, several months before the first joint venture wasformed, Deloitte U.S. partner David Herskovits sent AholdSenior Vice President Cor Sterk a memorandum providingdetails on the consolidation of joint venture revenue. Itexplained that control of a joint venture is required for consol-idation of the venture’s revenue and discussed what situationsare sufficient to demonstrate control. The memo indicated thatcontrol could be shown by a majority voting interest, a largeminority voting interest under certain circumstances, or by acontractual arrangement.

Ahold began consolidating the joint ventures as they wereformed. The various Joint Venture Agreements ("JVAs") didnot indicate that Ahold controlled the ventures. For example,


the JMR joint venture agreement specified that decisionswould be made by a board of directors, "deciding unani-mously," and that the board would consist of three membersappointed by Ahold and four members appointed by JMH,Ahold’s partner in the venture.

However, Ahold represented to Deloitte Netherlands that itnonetheless possessed the control requisite for consolidation.Deloitte Netherlands initially accepted these representationsfor the consolidation of JMR and Bompreço. But as consoli-dation continued, the Deloittes became concerned that Aholdlacked the control necessary to consolidate these first twojoint ventures. On August 24, 1998, Deloitte Netherlandspartner John van den Dries sent a letter to Michiel Meurs,Ahold’s CFO, advising him that Ahold’s representations ofcontrol would no longer suffice, that Ahold would need toproduce more evidence of control in order to justify continu-ing consolidation of joint venture revenue under U.S. GAAP,and that without such evidence a financial restatement wouldbe required.

In response to Deloitte Netherlands’ requests, Aholddrafted a "control letter" addressed to BompreçoPar S.A., itspartner in the Bompreço joint venture. The letter stated thatthe parties agreed that if they were unable to reach a consen-sus decision on a particular issue, "Ahold’s proposal to solvethat issue will in the end be decisive." After reviewing thedraft letter, Deloitte Netherlands advised Ahold that if coun-tersigned by the joint venture partner the letter would be suffi-cient evidence to consolidate the venture. The letter wassigned by Ahold and BompreçoPar in May 1999. By late2000, Ahold had obtained similar countersigned control let-ters for the ICA, DAIH, and Paiz-Ahold joint ventures. Basedon these letters and other evidence, Deloitte Netherlands con-cluded that consolidation was appropriate.

However, in October 2002 the Deloittes learned of a "sideletter" sent to Ahold in May 2000 by one of Ahold’s ICA


joint venture partners, Canica. The letter stated that Canicadid not agree with the interpretation of the shareholder agree-ment stated in the ICA control letter. At this point, DeloitteNetherlands and Deloitte U.S. began trying to get Ahold toobtain an amendment to the shareholder agreement in order tojustify ongoing consolidation. At a February 14, 2003 meet-ing, Deloitte Netherlands and Deloitte U.S. told Ahold thatAhold lacked the necessary control for consolidation.

On February 22, 2003, Ahold revealed to Deloitte Nether-lands side letters contradicting the Bompreço, DAIH, andPaiz-Ahold control letters. Two days later, Ahold announcedthat it had improperly consolidated its joint ventures andwould be restating its revenues.

B.

Now we turn to the PA fraud. Ahold acquired USF in early2000. Prior to the acquisition, Deloitte U.S. participated inAhold’s due diligence on USF. In a February 2000 memo,Deloitte U.S. noted that USF’s internal system for recordingpromotional allowances received was weak because it heavilyrelied on vendors’ figures, and that the system could "easilyresult in losses and in frauds." Deloitte U.S. also noted in thememo that USF’s use of value added service providers, spe-cial purpose entities that bought products from vendors andthen resold them to USF for a higher price, needed to be eval-uated for their "tax and legal implications and associated busi-ness risks."

After Ahold’s acquisition of USF was finalized, DeloitteU.S. became USF’s external auditor. When performing anOpening Balance Sheet audit of USF, Deloitte U.S. discov-ered that a USF division in Buffalo, New York had beenfraudulently accounting for PA income. This fraud required arestatement of $11 million of PA income. USF also down-wardly adjusted its income by $90 million as a result of


Deloitte U.S.’s advice that it be less aggressive in its methodfor recognizing PA income.

USF used at interim periods a method known as the "PArecognition rate" to estimate promotional allowance income,in which PAs were estimated as a percentage of USF’s totalsales. The rate used by USF was 4.58 percent at the time ofAhold’s acquisition of USF, but rose as high as 8.51 percentin 2002. When USF booked final numbers, Deloitte U.S. in itsaudits tested USF’s recognition of PAs by requesting writtenconfirmation of PA amounts from vendors and by performingcash receipt tests. Using this confirmation process, DeloitteU.S. was able to test between 65 and 73 percent of PA receiv-ables in its audits for 2000 and 2001.

Because USF lacked an internal auditing department, inApril 2000 Ahold USA, Inc. (Ahold’s American holding com-pany) hired Deloitte U.S. to perform internal auditing servicesat USF. The internal auditors did not report to the DeloitteU.S. external auditors.2 Instead, they reported initially toAhold USA’s internal audit director and, later, to USF’s inter-nal audit director after he was hired. The audit was managedby Jennifer van Cleave under the supervision of Patricia Gru-bel, a Deloitte U.S. Partner.

One of the internal audit’s objectives was to determinewhether USF’s tracking of PAs was adequate. In van Cleave’sattempt to verify USF’s PA numbers, she requested a numberof documents from USF management, including vendor con-tracts. Management refused to produce a number of therequested documents. Several members of management alsorefused to meet with van Cleave when she asked to conductexit meetings. Van Cleave was thus unable to complete all ofthe audit’s objectives.

2Under the professional standards then in effect, an auditing firm couldprovide both internal and external auditing services to the same client. SeeThe American Institute of Certified Public Accountants, Principles of Pro-fessional Conduct, § 101.15 (2000). (J.A. 4502-04.)


In a February 5, 2001 draft report, van Cleave describedhow management’s failure to produce requested documentsresulted in her inability to complete some of the goals of theaudit. Grubel instructed van Cleave to soften the report’s lan-guage, and the version submitted to Michael Resnick, Direc-tor of USF’s Internal Audit Department, simply stated thatDeloitte U.S. "was unable to obtain supporting documentationfor some of the promotional allowance sample items" withoutmore specifically detailing management’s failures.

In its February 2003 external audit for 2002, Deloitte U.S.discovered through the PA confirmation process that USF hadbeen inflating its recorded PA income. An investigationensued. Ultimately, USF’s former Chief Marketing Officer("CMO"), Mark Kaiser, was convicted on all counts of a fed-eral indictment that alleged that he had induced USF’s ven-dors to falsely report PA income amounts and receivablebalances to Deloitte U.S. and that he had concealed the exis-tence of written contracts with USF vendors from DeloitteU.S.

Two other USF executives pled guilty to federal securitiesfraud charges; in their plea colloquies, they admitted that USFlied to and deceived Deloitte U.S., and that they induced ven-dors to sign false audit confirmation letters that falsely over-stated PA payments. In addition, seventeen individualsassociated with USF vendors pled guilty to various charges,and admitted that they signed false audit confirmation lettersin order to conceal the PA fraud from Deloitte U.S.

III.

A.

In passing the PSLRA in 1995, Congress imposed height-ened pleading requirements for private securities fraudactions. As a general matter, heightened pleading is not thenorm in federal civil procedure. The drafters of the original


Federal Rules of Civil Procedure rejected technical pleadingrequirements and instead sought to ensure "that pleadings[would] be construed liberally so as to do substantial justice."5 Charles Alan Wright & Arthur R. Miller, Federal Practiceand Procedure § 1202, at 87 (3d ed. 2004). Embodying thisgoal, Federal Rule of Civil Procedure 8 requires merely "ashort and plain statement of the claim showing that thepleader is entitled to relief." Fed. R. Civ. P. 8(a)(2).

However, for several reasons it has long been believed thatheightened pleading requirements are necessary for allega-tions of fraud. Frequently stated reasons include protectingdefendants’ reputations from baseless accusations, eliminatingunmeritorious suits that are brought only for their nuisancevalue, discouraging fishing expeditions brought in the dimhope of discovering a fraud, and providing defendants withdetailed information in order to enable them to effectivelydefend against a claim. See 5A Wright & Miller § 1296, at 31-39. Thus Rule 9(b) of the Federal Rules creates an exceptionto Rule 8’s relaxed standard. When "alleging fraud or mis-take," plaintiffs "must state with particularity the circum-stances constituting fraud or mistake." Fed. R. Civ. P. 9(b).

Under § 10(b) of the Securities Exchange Act, it is unlaw-ful "[t]o use or employ, in connection with the purchase orsale of any security . . . any manipulative or deceptive deviceor contrivance in contravention of such rules and regulationsas the [SEC] may prescribe . . . ." 15 U.S.C § 78(j)(b). Pursu-ant to § 10(b), the SEC has promulgated Rule 10b-5, whichforbids employing "any device, scheme, or artifice to defraud,. . . mak[ing] any untrue statement of a material fact or omit[-ting] to state a material fact . . . or . . . engag[ing] in any act,practice, or course of business which operates or would oper-ate as a fraud or deceit upon any person." 17 C.F.R.§ 240.10b-5. Section 10(b) creates a private right of action forpurchasers or sellers of securities who have been injured bythe statute’s violation. See, e.g., Superintendent of Ins. of


State of N.Y. v. Bankers Life & Casualty Co., 404 U.S. 6, 13n.9 (1971).

As § 10(b) prohibits fraud, claims brought under it prior tothe PSLRA were governed by Federal Rule of Civil Proce-dure 9(b), not Rule 8. Tellabs, 127 S. Ct. at 2507. However,circuits split on the question of how much factual specificityRule 9(b) required of complaints alleging claims under§ 10(b). See William C. Baskin III, Note, Using Rule 9(b) toReduce Nuisance Securities Litigation, 99 Yale L.J. 1591,1593-94 (1990). Thus, Congress passed the PSLRA to estab-lish a uniform pleading standard that would reduce frivoloussecurities fraud suits. "As the Committee of Conference thatreported the PSLRA noted, ‘[Rule 9(b)] has not preventedabuse of the securities laws by private litigants. Moreover, thecourts of appeals have interpreted Rule 9(b)’s requirement inconflicting ways, creating distinctly different standardsamong the circuits.’" Teachers’ Retirement Sys. of La. v.Hunter, 477 F.3d 162, 171 (4th Cir. 2007) (quoting H.R. Rep.No. 104-369, at 41 (1995) (Conf. Rep.), reprinted in 1995U.S.C.C.A.N. 730, 740).

The PSLRA imposed a number of requirements designed todiscourage private securities actions lacking merit. Amongthem is the requirement that in a private securities action "inwhich the plaintiff may recover money damages only onproof that the defendant acted with a particular state of mind,the complaint shall, with respect to each act or omissionalleged to violate this chapter, state with particularity factsgiving rise to a strong inference that the defendant acted withthe required state of mind." 15 U.S.C § 78u-4(b)(2). Com-plaints that do not adequately plead scienter are to be dis-missed. Id. § 78u-4(b)(3)(A).

Because the PSLRA did not define "a strong inference," thecourts of appeals again disagreed on how much factual speci-ficity plaintiffs must plead in private securities actions. SeeMakor Issues & Rights, Ltd. v. Tellabs, Inc., 437 F.3d 588,


601 (7th Cir. 2006) (listing approaches of different circuits),vacated and remanded, 127 S. Ct. 2499. The Supreme Courtrecently resolved that issue in Tellabs, in which the Court pre-scribed the following analysis for Rule 12(b)(6) motions todismiss § 10(b) actions:

First, . . . courts must, as with any motion to dis-miss for failure to plead a claim on which relief canbe granted, accept all factual allegations in the com-plaint as true . . . .

Second, courts must consider the complaint in itsentirety, as well as other sources courts ordinarilyexamine when ruling on Rule 12(b)(6) motions todismiss . . . . The inquiry, as several Courts ofAppeals have recognized, is whether all of the factsalleged, taken collectively, give rise to a strong infer-ence of scienter, not whether any individual allega-tion, scrutinized in isolation, meets that standard.

Third, in determining whether the pleaded factsgive rise to a "strong" inference of scienter, the courtmust take into account plausible opposing inferences. . . . The strength of an inference cannot be decidedin a vacuum. The inquiry is inherently comparative:How likely is it that one conclusion, as compared toothers, follows from the underlying facts? . . . . [T]heinference of scienter must be more than merely "rea-sonable" or "permissible" — it must be cogent andcompelling, thus strong in light of other explana-tions. A complaint will survive, we hold, only if areasonable person would deem the inference ofscienter cogent and at least as compelling as anyopposing inference one could draw from the factsalleged.

127 S. Ct. at 2509-10 (citations and footnote omitted).


To be sure, by no means did the PSLRA or the SupremeCourt eliminate the private right of action in § 10(b), whichremains "an essential supplement to criminal prosecutions andcivil enforcement actions brought, respectively, by theDepartment of Justice and the [SEC]." Tellabs, 127 S. Ct. at2504. The "strong inference" requirement is not meant to pre-vent litigants with meritorious claims from continuing touncover fraud and ensure confidence in the securities markets.Rather, the requirement aims to weed out meritless claims atthe pleading stage, without forcing defendants to go througha potentially costly discovery process.

Thus, as directed by Tellabs, we must analyze the factualallegations raised by the plaintiffs, as well as other evidencein the record, and determine what plausible inferences we candraw from them. Having drawn all plausible inferences, wemay reverse the district court only if we find the inferencethat Deloitte Netherlands and Deloitte U.S. acted with scienter"at least as compelling" as the inference that the defendantslacked the required mental state. In this endeavor, we "mustconsider plausible nonculpable explanations for the defen-dant’s conduct, as well as inferences favoring the plaintiff."Tellabs, 127 S. Ct. at 2510. It is to this comparative analysisthat we now turn.

B.

The "strong inference" requirement and the comparativeanalysis of inferences still leave unanswered the question ofexactly what state of mind satisfies the scienter requirementof a 10b-5 action. In Ernst & Ernst v. Hochfelder, 425 U.S.185 (1976), the Supreme Court held that a plaintiff must showthat the defendant possessed the "intent to deceive, manipu-late, or defraud" in an action brought under § 10(b) and Rule10b-5. Id. at 193. However, the Court has never made clearwhat mental state suffices to meet this requirement. See id. at193-94 n.12 ("We need not address here the question whether,in some circumstances, reckless behavior is sufficient for civil


liability under s 10(b) and Rule 10b-5."); Tellabs, 127 S. Ct.at 2507 n.3 ("The question whether and when recklessnesssatisfies the scienter requirement is not presented in thiscase.").

This court has held that "a securities fraud plaintiff mayallege scienter by pleading not only intentional misconduct,but also recklessness." Ottman v. Hanger Orthopedic Group,Inc., 353 F.3d 338, 344 (4th Cir. 2003). We have defined areckless act in the § 10(b) context as one "‘so highly unrea-sonable and such an extreme departure from the standard ofordinary care as to present a danger of misleading the plaintiffto the extent that the danger was either known to the defen-dant or so obvious that the defendant must have been awareof it.’" Id. at 343 (quoting Phillips v. LCI Int’l, Inc., 190 F.3d609, 621 (4th Cir. 1999)). A showing of mere negligence,however, will not suffice to support a § 10(b) claim. See Ernst& Ernst, 425 U.S. at 199.

Thus, the question is whether the allegations in the com-plaint, viewed in their totality and in light of all the evidencein the record, allow us to draw a strong inference, at least ascompelling as any opposing inference, that the Deloitte defen-dants either knowingly or recklessly defrauded investors byissuing false audit opinions in violation of Rule 10b-5(b) or10b-5(a) and (c). If we find the inference that defendantsacted innocently, or even negligently, more compelling thanthe inference that they acted with the requisite scienter, wemust affirm.3 Plaintiffs must show that defendants actuallymade a misrepresentation or omission in their audit opinionson which investors relied; parties who merely assist another

3We review a district court’s denial of a motion for leave to amend acomplaint for abuse of discretion. Nourison Rug Corp. v. Parvizian, 535F.3d 295, 298 (4th Cir. 2008). However, because the district court deniedleave to amend because it determined that the amended complaint wouldnot survive a motion to dismiss, we review that legal conclusion de novo.See HCMF Corp. v. Allen, 238 F.3d 273, 277 n.2 (4th Cir. 2001).


in violating § 10(b) are not liable under § 10(b).4 SeeStoneridge Investment Partners, LLC v. Scientific-Atlanta,Inc., 128 S. Ct. 761 (2008).

IV.

A.

In light of the foregoing standards, we consider first the JVfraud. Plaintiffs allege that Deloitte U.S. and Deloitte Nether-lands allowed Ahold to consolidate the joint ventures despiteknowing, or being reckless with regard to the risk, that Aholdlacked the control required for consolidation. The thrust ofplaintiffs’ argument is that the control letters and Ahold’s oralrepresentations were insufficient evidence of control underDutch and U.S. GAAP. Thus, they argue, the defendants werecomplicit in the fraud. According to plaintiffs, the secret sideletters, in which the joint venture partners contradictedAhold’s interpretations of the joint venture agreements in thecontrol letters, are irrelevant because the control letters them-selves did not amend the joint venture agreements.

Plaintiffs’ arguments do not provide a basis for a stronginference that either Deloitte U.S. or Deloitte Netherlandsacted knowingly or recklessly in relation to the JV fraud. Themost plausible inference that one can draw from the fact thatAhold concealed the side letters from its accountants is thatthe accountants were uninvolved in the fraud. Ahold producedletters attesting to Ahold’s control countersigned by Ahold’s

4The SAC recounts a number of alleged misrepresentations by DeloitteNetherlands, including audit opinions issued in conjunction with Ahold’s1999 SEC Form 20-F, 2000 Form 20-F, 2001 Form 20-F, and Ahold’sSeptember 2001 Prospectus Supplement. Defendants contend in their briefthat Deloitte U.S. did not issue any audit opinions on Ahold’s or USF’sfinancial statements. Brief of Appellees at 1-2. Because this case wasbriefed and argued purely as a scienter case, and because defendants makeno argument that Stoneridge precludes liability, we do not consider theapplicability of that case.


partners for the ICA, Bompreço, DAIH, and Paiz-Ahold jointventures at the Deloitte defendants’ request, all the while con-cealing the side letters from those same defendants. Thesefacts lead to a strong inference that the Deloitte defendantswere attempting to ensure that Ahold had sufficient controlover the joint ventures for consolidation and that Ahold wasdetermined to prevent them from discovering otherwise.

With perfect hindsight, one might posit that defendantsshould have required stronger evidence of control fromAhold. Indeed, as the district court noted, it may have beennegligent for defendants to accept as the only evidence ofcontrol Ahold’s repeated representations that it controlledJMR, the one joint venture for which Ahold never produceda control letter. See In re Royal Ahold, 351 F. Supp. 2d at395-96.5 Nonetheless, the evidence as a whole leads to thestrong inference that defendants were deceived by their clientsinto approving the consolidation. Ahold would not haveneeded to go out of its way to produce false evidence of con-trol had the Deloittes been complicit in the fraud, or had theybeen so reckless in their duties that their audit "amounted tono audit at all," as the Southern District of New York hasdescribed the standard. S.E.C. v. Price Waterhouse, 797 F.Supp. 1217, 1240 (S.D.N.Y. 1992) (citing McLean v. Alexan-der, 599 F.2d 1190, 1198 (3d Cir. 1979)).

In order to establish a strong inference of scienter, plaintiffsmust do more than merely demonstrate that defendants shouldor could have done more. They must demonstrate that theDeloittes were either knowingly complicit in the fraud, or soreckless in their duties as to be oblivious to malfeasance thatwas readily apparent. The inference we find most compellingbased on the evidence in the record is not that the defendantswere knowingly complicit or reckless, but that they were

5Because JMR comprised a relatively small portion of Ahold’s financialresults, the district court found that any financial misstatement resultingfrom its consolidation was immaterial. 351 F. Supp. 2d at 395-96.


deceived by their client’s repeated lies and artifices. Perhapstheir failure to demand more evidence of consolidation wasimproper under accounting guidelines, but that is not the stan-dard, which "requires more than a misapplication of account-ing principles." Price Waterhouse, 797 F. Supp. at 740.

B.

Next we examine the PA fraud. Plaintiffs argue thatDeloitte U.S. was knowingly complicit in the fraud when itignored several "red flags," including: USF’s lack of internalcontrols to track PA income; USF management’s obstructionof the internal audit; and the facts and the circumstances ofUSF Chief Financial Officer Ernie Smith’s resignation.6

With respect to USF’s problems with tracking income withPAs, it is not the case that Deloitte U.S. simply ignored theweak internal controls, as plaintiffs allege. Rather, DeloitteU.S. raised this issue numerous times with Ahold and USFmanagement. Deloitte U.S. designed a confirmation processto verify USF’s reported PA income in which it contactedthird-party vendors and received letters from them confirmingPA amounts.

In the SAC plaintiffs describe the confirmation process asone that "confirmed nothing." Yet instead of merely relyingon USF CMO Mark Kaiser’s representations, as plaintiffsassert, Deloitte U.S. obtained corroboration from vendors forthe figures provided by USF. Deloitte U.S. would not haveattempted to verify USF’s figures with third parties if it werecomplicit in the scheme; nor can it be said that it was anythingbut proper to attempt to check the accuracy of representationsmade by USF management.

6Plaintiffs do not distinguish Deloitte U.S. and Deloitte Netherlands intheir complaint, but they have failed to challenge the district court’s con-clusion that the two firms are separate legal entities.


Plaintiffs attempt to suggest that the confirmation processwas unsound because, for example, Deloitte U.S. acceptedconfirmation letters via fax and the letters were sent to bro-kers or sale executives instead of financial officers. But evenif the confirmation process was somewhat flawed — whichdefendants contest — the larger fact remains that the PA fraudwent undetected initially only because USF and its vendorsconspired to lie to Deloitte U.S. and to conceal important doc-uments. Indeed, it was Deloitte U.S.’s confirmation processitself that ultimately revealed the fraud. In the course of the2002 audit, Deloitte U.S. learned in early 2003 from a vendorfrom which it had requested PA confirmations that employeeshad signed inaccurate confirmation letters. Shortly thereafter,Ahold authorized an internal investigation that revealed theextent of the fraud. No doubt it would have been better hadthe fraud been discovered earlier, but the strongest inferenceone can draw from the evidence is that the fraud initially wentundetected because of USF’s collusion with the vendors, notbecause of wrongdoing by Deloitte U.S.

As to the internal audit, the internal auditors reported notto the Deloitte U.S. external auditors but to USF, as was con-sistent with professional standards. See Standards for the Pro-fessional Practice of Internal Auditing, Statements on InternalAuditing Standards Nos. 1-18, § 230. Plaintiffs suggest thatGrubel’s editing of the language in van Cleave’s initial reportindicates scienter. They argue that Grubel’s edits suggest thatDeloitte U.S. was trying to cover up the fact that managementhad obstructed the internal audit. But as the district courtnoted, "while [the] language in the initial draft of the internalaudit report was softened, the revised language continued tostate the essential point, that the internal auditors had beenunable to obtain certain documents related to promotionalallowances and unable to achieve specific testing objectives."J.A. 6122.

The rest of the supposed "red flags" pointed to by plaintiffsalso fail to create a strong inference of scienter. With respect


to plaintiffs’ allegations that Smith told Deloitte U.S. aboutthe vendor rebate fraud, the district court twice concluded thatthis claim had no support in the record, and we see no reasonto disagree with its conclusion. Plaintiffs allege that facts likethe high CFO turnover at USF and USF’s rapid growth shouldhave alerted Deloitte U.S. that there was fraud afoot, but theydo not explain why this was the only conclusion Deloitte U.S.could have drawn without being reckless. There are manypossible reasons other than fraud for high personnel turnover— personality conflicts, lack of opportunities for advance-ment, salary and compensation disputes, to name a few.

Seeing the forest as well as the trees is essential. Withrespect to both frauds, plaintiffs point to ways that defendantscould have been more careful and perhaps discovered thefrauds earlier. But plaintiffs cannot escape the fact that Aholdand USF went to considerable lengths to conceal the fraudsfrom the accountants and that it was the defendants that ulti-mately uncovered the frauds. The strong inference to bedrawn from this fact is that Deloitte U.S. and Deloitte Nether-lands lacked the requisite scienter and instead were deceivedby Ahold and USF. That inference is significantly more plau-sible than the competing inference that defendants somehowknew that Ahold and USF were defrauding their investors.

It is not an accountant’s fault if its client actively conspireswith others in order to deprive the accountant of accurateinformation about the client’s finances. It would be wrong andcounter to the purposes of the PSLRA to find an accountantliable in such an instance. Because we find no version of thefacts creates a strong inference that the Deloitte defendantshad the scienter required for a cause of action under § 10(b),the district court rightly denied the plaintiffs’ motion for leaveto amend their complaint.

V.

We establish no blanket immunity for accountants for oth-erwise actionable statements with a strong inference of


scienter. But in this case, the stronger and more plausibleinference is that the Deloittes were, like the plaintiffs, victimsof Ahold’s fraud rather than its enablers. Plaintiffs’ action isthe paradigm situation to which the PSLRA and Tellabs weremeant to apply. Accordingly, the judgment below is

AFFIRMED.


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